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Basics of Loan and Mortgage Systems

Olivia Rosso

05/08/2018 12:46AM

The loan one is the cornerstones of today’s financial landscape and modern lifestyle. Almost every individual or family, in one form or another, has a loan. The irony of course is that principals, mortgage, amortizations, refinancing are highly numerical and technical concepts and a lot is misunderstood about the whole loan system. To most consumers, loans are simply “buy now pay later” options that comes with monthly payments.

First, while loans is the general term for an amount borrowed, mortgage refers to a type of loan secured for and with real estate property.

Let’s say a person comes to a bank or lending institution to apply for a mortgage. The bank or lending institution has to determine exactly the maximum amount than can be loaned to the applicant. The bank or lending institution computes this through the collateral, the property owned by the loan applicant that he, she or they ‘offer’ as insurance that they have something of value that the bank or lending institution may take away in case he, she or they fail to pay the loan. In determining mortgage rates and value, houses, land, cars or businesses can serve as collaterals.

The bank or lending institution then determines the value of the collateral and loans 80% of the total value of the property to the applicant. The resulting amount is then referred to as the principal which is simply the total value of the loan. But since the bank’s money needs to earn considering it can only be paid over extended period plus the fact that they will use resources in processing applications, in receiving and monitoring payments, they need to ‘earn’ from the whole transactions, they impose additional amount to the principal. This is called interest which is usually computed around 2-8% of the principal loan amount. This is also referred to as mortgage rate which roughly the principal plus the interest which is divided into the number of years and months when the loan is expected to be paid and can vary from a year to as much as 25 years. The resulting amount is the amortization which is often expressed in the monthly payment or the amount that the debtor will pay over a certain period in order to settle his, her or their mortgage.

Although loan system used to operate simply in previous decades, it is no longer as simple nowadays. Before, loans were computed and paid based on fixed low interest rates paid regularly over considerably long periods as much as 30 years. The introduction of the adjustable mortgage rate system in the 80’s also introduced the concept or repayment or loan readjustment system. Under the adjustable rate scheme, banks and lending institutions could offer lower interest rates for an initial year but can adjusted these rates every year for as long as the loan is unpaid which is why mortgage rates today can change year in and year out. The new mortgage rate adjustment system also introduced a number of mortgage rate and refinancing services today that can pay for a loan secured in another institution and provide debtors to lower mortgage refinancing options for debtors.